PMM Backtesting Results

Table of Contents

PMM Backtesting Results

This is a discussion of the back testing for the DecisionPoint Price Momentum Model (PMM). DecisionPoint did most of this backtesting during most of the 1990s, which was mostly a period of bull market conditions. Using the PMM, we back tested data on 32 of the Fidelity Select Mutual Funds from the beginning of January 1990 to the end of January 1998 - a little over seven years.

We have included SELL Signals for information only, to show how much of a decline may be missed as well as to illustrate the futility of investing against the primary market trend. Since these mutual funds cannot be shorted, the SELL Signal results are not part of our signal performance calculations.

Results

Total BUY Signals: 165
Total Profitable: 105 Signals lasting 625 days w/average profit of 56.0%
Total at a Loss: 60 Signals lasting 98 days w/average loss of -7.0%
Average one BUY Signal per fund every 15 months.
The Average BUY Signal lasted 433 days w/average profit of 33.1%
Total SELL Signals: 144
Total Profitable: 18 lasting 199 days w/average profit of 6.7%
Total at a Loss: 126 lasting 75 days w/average loss of -7.2%
The Average SELL Signal lasted 92 days w/average loss of -5.4%

Test Parameters

The model requires a beginning signal assumption, so we assumed that all funds tested would begin on a BUY Signal. Open and closing prices for each signal were assumed to be the closing NAV on the day the signal was generated. The effects of transaction fees, taxes, or compounding were not considered in the calculations. Some of the signals were still open at the end of the back test period and may not ultimately close as high as they were at the end of the test.

The data used were adjusted for distributions to insure a consistent relationship for determining gains and losses. We freely admit that changing these assumptions and parameters could substantially change the results. We made some quick choices so that we could get some idea of how the Model performs.

Conclusions

We reached certain conclusions from this back testing, as well as from our observations of the performance of the Momentum Model in real time over a period of several years.

The Model does very well with securities and market indexes that trend in a relatively orderly fashion. Volatility tends to result in loss-producing whipsaws. Consequently, the Model works best on market indexes and mutual funds where the volatility of individual stocks is attenuated by being averaged in with a large group of stocks. This is even the case with sector groups like technology, computers, etc. Performance of the Model on market indexes and mutual funds is approximately 50% to 70% better than on individual stocks.

The back testing was performed over a period when the broad market was in a secular bull market. As a result, the SELL Signals were routinely unprofitable, while BUY Signals were routinely profitable.

It is our observation based on the historical charts of these funds that virtually no sector can be expected to perform well in the face of a bear market. There will, of course, exceptions, and our Model will let profitable positions run even in the event of a bear market.

Our overall conclusion is that following the Momentum Model BUY Signals during a bull market (going to cash during SELL Signals) should keep one in the market when a position is performing well, and take one out of the position when the fund (sector) experiences a serious correction. This should allow for profitable exposure when warranted, and substantial reduction of risk.

CAVEAT: We cannot guarantee that following this strategy will result in future profits or protect from future loss. It is entirely possible that substantially different market conditions will sabotage the mechanical model, so it is imperative to understand how it works and what its weaknesses and strengths are. Models are great for screening candidates, but a real human brain must be responsible for ultimately putting actual money at risk.

Backtesting Signals

Below are the individual signals resulting from the back testing. We have listed the BUY Signals first, since they are the most relevant. Next we list the SELL Signals, and, finally, all signals shown in the sequence they were actually generated. In this last group, please note how the more volatile sectors funds experience periods of unprofitable whipsaw.

We show two results, the highest profit (or least loss) and the “Last” profit (loss) at the time the position was closed. This demonstrates in many cases how judicious use of charts and other analysis could allow exiting at a much higher profit than the Model captures on a mechanical basis.